After strengthening to 2.3% in 2024 real GDP growth is projected to settle at 2.1% in 2025 and 2026. Strong global demand will continue to support exports. Private consumption should pick up from late 2024 thanks to lower interest rates and rising real wages. Inflation will continue to undershoot the target in the near term. Increased female and elderly labour market participation will further boost employment, while unemployment will remain low.

The Bank of Korea cut the policy rate from 3.25% to 3.0% in November. Further cuts are expected to lower the policy rate to 2.5% in 2025, bringing inflation back to the 2% target. Fiscal consolidation is likely to commence in 2025, helped by the partial reversal of large revenue shortfalls in 2023 and 2024. The proposed fiscal rule, along with pension reform, would help rebuild fiscal buffers to meet expenditure pressures from rapid ageing. Immigration could help ease labour shortages, while labour market reforms could improve matching, reduce elderly poverty and lessen the high opportunity cost of motherhood.

Real GDP grew only marginally in the third quarter of 2024, after a very strong first quarter and a slight contraction in the second quarter. Domestic demand picked up, with positive contributions from private consumption, private non-housing investment and public consumption and investment. Headline inflation weakened to 1.3% in October 2024, well below the 2% inflation target, while inflation excluding food and energy came in at 1.8%. At 2.7%, the unemployment rate remained close to historical lows while the employment rate remained historically high at 62.7% in October 2024. Vacancies have been falling and nominal wage growth remains moderate, while labour shortages remain in sectors such as shipbuilding, health and welfare.

Strong global demand for Korean manufacturing goods, notably semiconductors, has driven growth in the past few quarters, but the contribution of manufacturing exports to growth is weakening. Exports contracted in the third quarter, while imports grew strongly in part related to factory investments. Customs exports are strengthening after a recent weak spot, rising by 5.8% compared to a year earlier in the first 20 days of November.

The Bank of Korea started its easing cycle by cutting the policy rate from 3.5% to 3.25% in October and lowered the rate further to 3.0% in late November. With inflation undershooting the target, the policy rate is assumed to bottom out at 2.5% in 2025. Continuing business tax revenue shortfalls will widen the deficit from 2023 to 2024. The fiscal balance should strengthen from 2025, as expenditure growth under the government's budget proposal is set to be low and solid corporate earnings in 2024 will boost future tax receipts. A temporary fuel tax relief has been extended a number of times since the energy crisis, but is assumed to end in mid-2025. Some further consolidation is also assumed in 2026, with an accumulated fiscal tightening of around 1% of GDP in the 2025-26 period.

After strengthening to 2.3% in 2024 output growth is projected to settle at 2.1% in 2025 and 2026. Private consumption and investments are expected to increasingly drive the expansion, as lower interest rates and real income growth boost purchasing power. Inflation is projected to remain below the 2% target in the short term, largely due to lower international energy and commodity prices. However, with firm action to loosen monetary policy, inflation is set to converge to target by the end of 2025. Labour participation should continue to expand, notably among women and older cohorts, while the unemployment rate stabilises at low levels. Growth could turn out lower than forecast should the period of high interest rates and weak disposable income growth have led to persistent increases in precautionary savings. Conversely, faster-than-expected improvement in consumer sentiment could result in stronger growth.

Unless monetary policy squarely prioritises the price stability objective over the secondary objective of financial stability inflation expectations may be de-anchored, leading to avoidable output and job losses. Tighter macroprudential regulations, reduced fiscal support for home ownership and structural reform to improve housing supply are much preferred instruments to keep financial imbalances in check. Fiscal tightening should continue as planned in light of rapid ageing, and the proposed fiscal rule should be implemented. Environmental taxes, increased auctioning in the emissions trading scheme and streamlining of state support to companies could create fiscal space to fill gaps in social protection and family policies. Korea’s labour shortages in sectors such as shipbuilding, health and welfare are set to intensify with ageing, calling for longer working lives and pension contribution periods, more immigration and better integration of immigrants as well as increased youth employment. Loosening employment protections for regular workers while improving work conditions and social protection of non-regular workers, and moving away from seniority-based wages and a workplace culture where work takes priority over family are key elements to achieve these aims and to allow female employment and fertility to rise in tandem.